Taking Stock of Shareholders' Rights

In several contests for corporate control during the last year, several courts ruling in favor of a target company's board of directors have distinguished Delaware corporation law regarding the rights of shareholders from the law of the target's state of incorporation. In New York, Georgia and Pennsylvania as well as Delaware, stockholders, who at least on paper own corporations, may find their interests further subordinated to those of directors and the corporation as a constituency unto itself. These rulings, coupled with the retirement of Chancellor William T. Allen from the Delaware Court of Chancery, provide an opportunity to assess the vitality of shareholder rights, a decade after the heyday of hostile takeovers.

The first of these rulings arose in a contest for control of Conrail, a Pennsylvania corporation. Conrail, the target, and CSX had entered into a merger agreement calling for a partial tender offer by CSX followed by a stock-for-stock merger. Subsequently, Norfolk Southern made a financially superior all-cash, all-shares tender offer for Conrail. Conrail's stockholders did not have the opportunity to decide for themselves which offer provided greater value, however, because Conrail's merger agreement with CSX prohibited the Conrail board from recommending any competing bids for 270 days or redeeming Conrail's poison pill.

The United States District Court for the Eastern District of Pennsylvania rejected Norfolk Southern's challenges to the Conrail-CSX merger agreement, holding that Pennsylvania's corporation law statute allowed Conrail's board of directors to consider factors other than the best interests of Conrail's stockholders.1 The Conrail Court criticized certain leading Delaware cases for adopting the "myopic view that[,] because stockholders are at least in theory the owners of the corporation[,] only their interests should be considered or at a minimum must be given the highest priority and importance."2 According to the Court, these Delaware cases completely ignore "the economic utility and value of corporations as a form of business enterprise that produces goods and services for the public and the national economy" and give judges the power to make decisions that are more reliably made by boards of directors.3

Several months after the Conrail decision, the United States District Court for the District of Connecticut, interpreting New York law, also distinguished Delaware's focus on shareholders amidst a contest for control of Dynamics Corporation of America ("DCA").4 The contest began when WHX, a Delaware corporation, made a partial tender offer for DCA.5 DCA then entered into a merger agreement with CTS,6 pursuant to which CTS would make a partial tender offer followed by a stock-for-stock merger.7 In response, WHX made an all-cash, all-shares tender offer that arguably exceeded the value of the CTS offer.8 Nonetheless, DCA's board of directors chose to exempt only the CTS bid from DCA's poison pill and from New York Business Corporation Law ("NYBCL") §912(b), an anti-takeover statute.9

The court upheld the board's decision, after observing that WHX would have been on "much stronger footing" if Delaware law applied.10 Applying New York law, the court observed that under NYBCL §505(a)(2) a board of directors can "take into account the condition of the corporation" when deciding whether to redeem a poison pill,11 and held that it was reasonable for the DCA board to conclude that the CTS offer was superior in value to the WHX offer.12

Three weeks later, the United States District Court for the Northern District of Georgia held that Healthdyne Technologies could use a "continuing director" poison pill to resist an all-cash, all-shares tender offer from Invacare Corporation.13 Such a poison pill prevented Healthdyne's shareholders from replacing its directors with a slate proposed by Invacare, because only the incumbents are deemed "continuing directors" and only "continuing directors" had the power to redeem the poison pill.14 The court concluded that Delaware caselaw was inconsistent with Georgia statutes, which embraced the concept of continuing directors. The court further stated that the poison pill did not interfere with the shareholders' right to elect a new board of directors.15

Had these three decisions been handed down nine years ago, their treatment of Delaware law as contrary authority would have been understandable. At that time, when state legislation protecting corporate constituencies other than shareholders was proliferating across the country, the Delaware Court of Chancery developed a legal rule that prevented a board of directors from using a poison pill to permanently foreclose shareholders from accepting an all-cash, all-shares tender offer. As Chancellor Allen reasoned at that time, if a tender offer is for all shares, "the threat posed, if any, is not importantly to corporate policies ... but rather the threat, if any, is most directly to shareholder interests."16 Due regard for shareholder interests allowed directors to maintain a poison pill temporarily - to explore an alternative transaction or to negotiate for a higher offer - but the shareholders themselves ultimately had a right to choose between the tender offer and whatever business plan or alternative transaction management proposed.

The vitality of this legal rule was soon called into serious question. In Paramount Communications v. Time Inc., the Delaware Supreme Court rejected the rationale behind Chancery Court precedent, holding that Time's board of directors could reasonably determine that Paramount's all-cash, all-shares tender offer "posed a threat to corporate policy and effectiveness."17 The court explicitly ruled that Time's board could act based on their concern that Time's shareholders might tender to Paramount in ignorance of, or based upon a mistaken belief about, the strategic benefits of an unconsummated business combination that Time's board had negotiated with Warner Communications. More importantly perhaps, the court implicitly endorsed Time's board's determination that the Paramount offer "posed a threat to Time's control of its own destiny and retention of the `Time Culture.'"18

I have elsewhere elaborated at length upon the historical and cultural significance of this decision by the Delaware Supreme Court.19 For present purposes it suffices to say that directors of Delaware corporations are afforded such increasingly great latitude in establishing and meeting corporate goals that they may be forgiven for thinking that they are permitted to pursue the immortality of the corporation itself, or their own conception of the corporation's purpose, rather than the economic interests of the corporation's owners. At least in the context of an unsolicited tender offer, shareholders of Delaware corporations have limited ability to argue that directors must act in their best interests.

I do not mean to suggest how a Delaware court today would adjudicate the cases confronted by the three federal courts mentioned above. No Delaware judge has recently encountered a fact pattern resembling the contests for control of Conrail or DCA, and no Delaware court has ruled on the validity of poison pills with "continuing director" provisions, such as that addressed in Invacare.

The Invacare decision does highlight, however, the fact that what may separate Delaware law from the law of other jurisdictions is Delaware's assiduous protection of stockholders' right to elect and remove directors. Chancellor Allen made this point clear in Blasius Industries v. Atlas Corporation: "The shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests."20 In Stahl v. Apple Bancorp, Inc., Chancellor Allen rejected "the notion that the prospect that the shareholders might vote differently than the board recommends can alone constitute any threat to a corporate interest."21 The Delaware Supreme Court has expressed its support of the basic legal tenets of Stahl and Blasius Industries.22

Chancellor Allen noted in Stahl that the view that a stockholder vote cannot be seen as a threat to the corporate entity or corporate constituency depends upon the law's acceptance of the "traditional model of the nature of the corporation, [which model] sees shareholders as 'owners.'"23 In light of the Paramount Communications decision and the opinions discussed above, adherence to this traditional model, both under Delaware law and under the law of other states, cannot be assumed.